X
GO
  • your peace of mind
    is our priority
  • unbiased advice
    to provide financial clarity
  • service is at the heart
    of what we do
  • key principles
    for pursuing a better investing experience
  • a collaborative approach
    to help you create the life you want
Filter Insights
Receive Insights in your inbox.

Third Quarter 2011 Quarterly Newsletter

posted on

"Lieutenant Dan got me invested in some kind of fruit company. So then I
got a call from him, saying we don't have to worry about money no more.
And I said, 'that's good. One less thing.' "
-- Forrest Gump


One Less Thing. Or Was It?

That’s the $64,000 question, because we don’t actually know what Forrest has done with his Apple stock since the bus picked up his son at the end of the movie. Investors who have watched Apple’s advance over the past couple of years probably think that it was a “no brainer” hold for Mr. Gump. After all, the stock has advanced 400% in the last 18 months. If Forrest still held it, it would be worth over 100 times what it was worth during the decade he bought it.

The problem, of course, is that he would have to be crazy to have held it this long. Why? Because during his holding period, the stock price was lower in 2003 than it was in 1987. That’s 16 years of dead money - zero or negative return on investment. Now I know Forrest was special, but how many investors, no matter how long term oriented, would have held an unproductive stock that long?

Apple is not unusual in this regard. In fact, some of the very “best” stocks have had unconscionable periods of zero or negative return. Take Big Blue. For the youngsters in the crowd, that’s IBM. At one time, it was the epitome of a blue chip stock. But, like Apple, IBM had a long period of no return. You could have purchased a share of IBM for less money in 1993 then in 1967. Now that’s a long term hold. And it doesn’t stop there. Bill Gates may again be the richest American on the Forbes 400 list, but not because Microsoft has done anything exciting lately. In fact, Microsoft stock is trading at lower prices today than it did in 1998.

The moral of this story is that being a long term holder of even the “best and brightest” stocks will often lag the broad market averages. The periods of stock underperformance discussed above may seem long, but at least they are still good companies that are competing in the global market place. There are many, many formerly outstanding blue chip companies that were the penultimate in their industry - only to be battered down by competition and obsolescence. Bethlehem Steel invented the I-Beam, and built the Golden Gate Bridge and thousands of other monuments to progress, only to go bankrupt. Eastman Kodak had seemingly unapproachable leadership, but is now a penny stock. Pan Am, Kmart and Polaroid all had huge, uncontested control in their industries, only to hit the refuse pile years later. (Remember Kmart has already gone bankrupt once. Seconds anyone?)

How do you circumvent this fate? Simply by not owning individual securities, no matter how great they may appear at the time. Asset classes will do something that few stock pickers can boast about. They will guarantee that you will own every wildly fantastic stock you read about. In our example, you will be certain to own Apple in your Large Cap asset class. Moreover, you will own a greater percentage of Apple the more its stock goes up. Over time, you will gradually own less of the companies that Apple is beating in the marketplace. And the real dogs, like Kodak, will only have a tiny presence. Plus, when one of those long term sideways stocks suddenly decides to explode to the upside, you will already own some and experience the entire, beautiful ride.

This is one of several reasons why asset class investing, over the long term, outperforms most actively managed investment strategies. Simply put, it is quite difficult to be in and out of winning and losing stocks at the right time, year after year. Asset classes always assure you will be in a greater weighting of winning stocks and having an ever decreasing weighting in losing stocks.

I’m guessing that Forrest Gump probably sold his Apple stock in early 2000, bought it again a couple years later, sold it in late 2007 and bought again in March of 2009. But the rest of us should stick with buying asset classes. Otherwise, as Forrest said, “Stupid is as stupid does.”

Third Quarter 2011 Asset Class Performance



All equity asset classes were crushed during the third quarter. A perfect storm consisting of a 1) reduced agency rating of US debt, 2) slowdown of the domestic economy, 3) seeming lack of leadership from all branches of the US government and, most importantly, 4) massive fear over certain European Community Union nations’ debt levels brought broad based selling to all major global exchanges. As is typical in this stage of a market panic, Small and Value Asset Classes generally underperformed Large and Core/Growth. Safety havens, such as government bonds, rallied dramatically, meaningfully increasing their (in our opinion) overvaluation. The first couple of trading days in October confirmed a bear market, defined as the S&P 500 piercing the 20% range from its previous bull market high.

Many investors are asking what’s next. Are we going into another recession, will the market continue its downtrend, and if so, how do we protect our portfolios? First, whether or not we actually have an official (two quarters of negative gross domestic product) recession is a matter of semantics only. We are undoubtedly going through a slowdown in the economy. What we actually call it is not as important as how long it may last or how deep it may go. Some economists believe there is some chance of a further slowing for the remainder of 2011 and even into 2012. Obviously, the stock market’s meaningful drop has already discounted much of this economic slowing, as well as fears of much more to come.

The single biggest reason for this market drop is Greece and other debt laden ECU member countries threatening to further weaken the entire European continent, and thereby affect the entire global economy. Wall Street awakens each morning and reacts to the most recent tidbit from across the Atlantic. The volatility reminds investors of the immense instability seen during the 2008-09 bear market. Interestingly, the economic situation in the US is quite different this time around. The banking industry is much healthier, with many major banks having excellent earnings and reserves, despite the economic slowdown. In addition, corporate America in general is in much better financial shape. Many companies are sitting on large cash hoards, which make their dividend payout structures more dependable than just a few years ago. By and large, US companies have been able to grow earnings even in this tenuous environment.

With this information, it seems like a poor time to leave the market in search of safety. By the time we know that the market is in a meaningful correction, it is usually closer to a normal bear market bottom, and therefore selling at that point is counterproductive. Remember that equity markets typically discount future news. They usually top out when there is no real evidence of major problems. They typically bottom and begin the next bull market months before there is any evidence of positive news.

In addition, there is reason to believe that stocks are meaningfully undervalued. For example, the current dividend yield on the S&P 500 Index is over 2.5%. The yield on the 10 year US Treasury bond is 1.8%. The last time this anomaly occurred was during the 1950’s, which incidentally led to a 20 year period of excellent stock returns. This, along with other stock valuation data, clearly points to the fact that although there is no guarantee stocks have hit their bottom, they clearly are undervalued. In addition, if an investor waits to invest until the “coast is clear” and the news is sunny, they will undoubtedly miss what is often the easiest and quickest portion of the next bull market’s positive returns.

For this reason, we do not disturb the risk/reward parameters of your portfolio. We will review the percentages of equity and income asset classes, and make sure the portfolio is properly balanced, which may entail buying some additional equity classes with income capital. This allows the portfolio to buy low (equity) and sell high (income) - which is the goal of all investors. This long term investment methodology has been highly successful in the past and will assure that when the next bull market commences, your portfolio will take full advantage of the opportunity.

As always, new clients will get a partial report, with a complete one to follow next quarter. By the end of the 4th quarter, we will have experienced Halloween, Thanksgiving and Christmas/Hanukah. Likewise, we can all hope that by the end of the year, the financial markets will be done scaring us, and we can be thankful for some year-end good tidings.

Sincerely,


Frederick F. Kramer IV, JD
Chief Investment Officer
Dixon Hughes Goodman Wealth Advisos LLC